Universal Service in a Liberalized Environment*

Michael A. CrewCRRI Professor of Regulatory

Economics, Director CRRI, Rutgers University

*Based on joint work with Paul Kleindorfer

Outline

1. What is the USO?

2. What is a Liberalized Environment?

3. How is the USO to be funded?

4. What should be the role of regulators and competition?

5. Summary and Implications

What is the USO?

• Generally: those activities (or social obligations) that a private (profit oriented) firm would not perform

• Specifically: – Ubiquity and uniformity for letters– Ubiquitous post offices or retail outlets– Limits on quality variability

What is a Liberalized Environment?

• Full Market Opening (FMO) – the culmination of liberalization

• POs traditional reserved area in letter mail gradually reduced

• Elimination 2011/13 – Defining event in liberalization process

A broader view of liberalization

• Liberalization is about direct competition and entry into all of the PO’s markets

• Consequent Transformation of POs

• New virtual technologies – strong driver of competition

• Inter modal competition nothing new; PO survived phone and fax

• Email and the Internet

Why is Internet different?

• Relatively much cheaper than traditional telecom based technologies

• More ubiquitous than fax

• Vast range of possibilities beyond email

• Almost as ubiquitous as telephone

• Wireless dimension

How is the USO to be funded?

• Traditionally reserved area funded the USO

• Uniform price enabled cross subsidies from low cost to high cost area

• Further surpluses used to fund extensive retail outlet network

• Barricaded entry to reserved area prevented cream skimming

Liberalization of the Postal Sector*

PO/USP Governance

Public PrivateM

arke

t S

tru

ctu

re

Monopoly

Competitive

PrivatizedInvestor-Owned

Enterprise

CommercialPublic Enterprise

“Planned” Pathof Postal Reform

*See Crew, Kleindorfer, Campbell, Handbook of Worldwide Postal Reform, Forthcoming, Edward Elgar, 2008.

How is the USO to be funded under liberalization?

1. Scale economies: POs derive scale economies from local delivery that may provide some cost advantages and some protection against entry.

2. Scope economies: POs expect to have scope economies between say letters and other products, particularly, parcels and financial services.

How is the USO to be funded under liberalization? (Continued)

3. Market dominance: POs may derive market power from e.g. scale economies, ubiquitous coverage and name recognition.

4. Increased X-efficiency

5. Increase in the uniform price of single-piece mail.

6. Reducing the scope and therefore the obligation of the USO

7. Extent of pricing flexibility allowed by regulators.

What should be the role of regulators and competition?

• All 7 items are of varying concern to regulator

• All interact making regulatory intervention difficult

• Underlying principle for regulation: -Avoid micromanagement by employing incentives for efficiency

Avoiding Micro management

• Scale and scope economies:- excessive concern for market power and not efficiencies from scale

• Presumption should be that incremental cost test is deemed sufficient

• Market dominance may be needed to finance USO. How much?

• Stay within limits of competition law

Increasing X-efficiency

• Perception that POs as inefficient civil-service type bureaucracies

• Liberalization an attempt to provide pressure for X-efficiency

• Change from bureaucracies to commercial of for-profit orientation need

• Avoid regulatory micro management and excessively high expectations

Uniform price and scope of USO

• Uniform price and scope of USO interrelated

• Scope of USO multidimensional

• Regulator concerned with:– Frequency of delivery– Number of PO retail outlets– Quality– Access

Design Incentives and provide transparency

• Incentives for quality important

• Design can lead to excess or too little quality and affect profits

• ANACOM approach– Consultation with CTT – attempt to provide

information to design incentive– Transparency in reporting – Castro et al (2009)

Access and the USO

• What is the role of access in the USO?• PO’s ubiquitous delivery arises from USO

– Makes access to its facilities attractive– Provides contribution toward covering the cost

of the USO

• Consensus that upstream access (worksharing) beneficial for the PO and its customers

• Profitable for worksharing companies

Downstream Access more problematical

• May be efficient for high cost areas to use PO’s delivery resulting from USO

• USO may make it difficult to compete for access in low cost areas

• USO may also mean access is priced below cost in high cost area

• Uniform single piece price place severe limits on PO/Regulator’s flexibility

Pitfalls of Micro Management: Worksharing /Access Different Possibilities

B

A

C

D

f

e

g Y

X

Z

B

A

C

D

f

e

g

Y

X

CollectionZones

Upstream ProcessingCenters

DownstreamProcessingCenters

DeliveryZone

First-ClassMail

SecondClassMail

Workshared Mail Streams from

WSP1,…., WSPn

Workshared Mail Streams from

WSP1,…., WSPn

Workshared Mail Streams from

WSP1,…., WSPn

Regulator’s limited flexibility

• Upstream entry may promote lower costs in low cost areas

• PO cannot avoid burden of USO

• SUSO impossible because business customers cannot be excluded from USO

• USO has some features of a public good

USO and Access under Downstream Entry

• Added problems

• PO’s surplus in low cost zones under pressure

• If access unregulated, PO will charge lower prices in low cost zone for E2E

• PO still limited in flexibility by uniform single-piece price

USO driver under E2E Competition

• If regulator sets access too low, little or no E2E competition

• If access price unregulated, can make greater surpluses or reduce losses

• Uniform single-piece price places lid on benefits of price flexibility on access and USO products

• Case for regulation of access weak

22

PH – CUE – ρB(zI)

Unit Delivery

Cost

Illustrating Business Mail Zones ServedBy Entrants and by the Incumbent under Entry (CUE < CUI)

0 TtA(M, zI)

CDI(t, z)

– ρB(zI)

Delivery Zone

Zones Serviced by

Incumbent underAccess

Zones t < tA Serviced E2Eby Entrants

(1+M)CDI(t, zI)– ρB(zI)

tU(PH, M, zI)

Zones t > tU

Serviced byIncumbent E2E at

Price PH

)t(CDE

Pricing Flexibility to fund USO

• If single-piece price is set too low it may limit the benefits of pricing flexibility

• Flexible pricing in competitive and access products might offer benefits

• Concern: PO allowed flexible pricing but the upside truncated by ex post regulation

Drivers

Market

Preparedness of the USP

Impact of scope and characteristics of USO

Regulatory policies

FMO impactsThemes

Postal scale, urbanisation, direct mail %, letter mail and bulk mail, postal density, …

Labour cost, efficiency,…

Counter density, frequency of delivery,…

Licensing, pricing, access,…

USP Financing needs

Benefits of Workablecompetition achieved

Scope & location of entry

Employment impact

Price and product changes in response to competition

Diversity of driver values

across countries

Variety of impacts across

countries

… that influence the…

PwC Study (2006)*: Model-based Assessment of the impact of FMO on the USO

*See http://ec.europa.eu/internal_market/post/studies_en.htm

Main Conclusion of EU Studies (further reflected in the 3rd Directive, 2008): There exist a variety of country specific

situations concerning FMO

SI

BE

FR

ESPT

GBIE

LU

NL DE

DK

SE

FI

EE

LV

LT

PL

CZSK

AT

IT

HU

GR

MT CY

NO

BG

RO

IS

Significantly above average

Above average

Below average

Significantly below average

121-145

101-120

80-100

65-80

Country-specific Re-Balancing

USOLabor Agreements

X-inefficiency, Entry

PO RestructuringPricing FlexibilityRegulatory Reform

Summary and Implications

• Maintaining USO will be more complicated

• At least 7 ways of funding the USO

• POs will need to continue to transform themselves with increased efficiency

• Challenge of preserving scale and scope economies

• Setting uniform single-piece major driver

Final Thoughts

• Single-piece price will increase• Scope of USO will decrease• POs become more efficient• Maintaining USO and viable PO• Avoid micro management• Incentives for efficiency• Transparency in regulation• Regulatory economics promising insights